Geo-Graphicshttp://blogs.cfr.org/geographics
A graphical take on geoeconomic issues, with links to the news and expert commentary.Thu, 02 Jul 2015 19:39:04 +0000en-UShourly1http://wordpress.org/?v=4.2.2Greece Fallout: Italy and Spain Have Funded a Massive Backdoor Bailout of French Bankshttp://blogs.cfr.org/geographics/2015/07/02/greecefallout/
http://blogs.cfr.org/geographics/2015/07/02/greecefallout/#commentsThu, 02 Jul 2015 13:00:05 +0000http://blogs.cfr.org/geographics/?p=2561In March 2010, two months before the announcement of the first Greek bailout, European banks had €134 billion worth of...]]>

In March 2010, two months before the announcement of the first Greek bailout, European banks had €134 billion worth of claims on Greece. French banks, as shown in the right-hand figure above, had by far the largest exposure: €52 billion – this was 1.6 times that of Germany, eleven times that of Italy, and sixty-two times that of Spain.

The €110 billion of loans provided to Greece by the IMF and Eurozone in May 2010 enabled Greece to avoid default on its obligations to these banks. In the absence of such loans, France would have been forced into a massive bailout of its banking system. Instead, French banks were able virtually to eliminate their exposure to Greece by selling bonds, allowing bonds to mature, and taking partial write-offs in 2012. The bailout effectively mutualized much of their exposure within the Eurozone.

The impact of this backdoor bailout of French banks is being felt now, with Greece on the precipice of an historic default. Whereas in March 2010 about 40% of total European lending to Greece was via French banks, today only 0.6% is. Governments have filled the breach, but not in proportion to their banks’ exposure in 2010. Rather, it is in proportion to their paid-up capital at the ECB – which in France’s case is only 20%.

In consequence, France has actually managed to reduce its total Greek exposure – sovereign and bank – by €8 billion, as seen in the main figure above. In contrast, Italy, which had virtually no exposure to Greece in 2010 now has a massive one: €39 billion. Total German exposure is up by a similar amount – €35 billion. Spain has also seen its exposure rocket from nearly nothing in 2009 to €25 billion today.

In short, France has managed to use the Greek bailout to offload €8 billion in junk debt onto its neighbors and burden them with tens of billions more in debt they could have avoided had Greece simply been allowed to default in 2010. The upshot is that Italy and Spain are much closer to financial crisis today than they should be.

]]>http://blogs.cfr.org/geographics/2015/07/02/greecefallout/feed/9A Full Greek IMF-Debt Default Would Be Four Times All Previous Defaults Combinedhttp://blogs.cfr.org/geographics/2015/06/24/greekdefault/
http://blogs.cfr.org/geographics/2015/06/24/greekdefault/#commentsWed, 24 Jun 2015 15:17:57 +0000http://blogs.cfr.org/geographics/?p=2552Since the IMF’s launch in 1946, 27 countries have had overdue financial obligations of 6 months or more.* But the...]]>

Since the IMF’s launch in 1946, 27 countries have had overdue financial obligations of 6 months or more.* But the amounts involved have always been small, never exceeding SDR 1bn ($1.4bn).

This could all change dramatically with Greece, which will default on the SDR 1.2bn ($1.7bn) it owes the Fund next week unless its troika creditors agree to extend further financial assistance before then. Greece owes the IMF SDR 4.4bn ($6.2bn) through the end of this year and SDR 18.5bn ($26bn) over the coming ten years. As shown in the graphic above, this is nearly four times the cumulative total of overdue funds in the IMF’s history.

Although Greek prime minister Alexis Tsipras has blasted the Fund for “pillaging” Greece, the conditions it has imposed on the country have been mild by historical standards – particularly considering the size of the loans involved. Non-payment by a European state will surely undermine the IMF’s credibility in the eyes of developing countries, and likely accelerate efforts to build alternative institutions.

Next up: Ukraine . . .

* “Defaults” in the post title are defined as financial obligations overdue by six months of more, or what the IMF refers to as “protracted arrears.”

]]>http://blogs.cfr.org/geographics/2015/06/24/greekdefault/feed/1Greece and Its Creditors Should Do a Guns-For-Pensions Dealhttp://blogs.cfr.org/geographics/2015/06/23/gunsforpensions/
http://blogs.cfr.org/geographics/2015/06/23/gunsforpensions/#commentsTue, 23 Jun 2015 13:33:50 +0000http://blogs.cfr.org/geographics/?p=2548IMF Chief Economist Olivier Blanchard has said that Greece needs to slash pension spending by 1% of GDP in order...]]>

IMF Chief Economist Olivier Blanchard has said that Greece needs to slash pension spending by 1% of GDP in order to reach its new budget targets. The Greek government continues to resist, arguing that Greeks dependent on pensions have already suffered enough. But it has yet to put a compelling alternative to its creditors.

What depresses us is how little attention has been paid to one major area of Greek government spending that seems ripe for the ax: defense spending. Greece spends a whopping 2.2% of GDP on defense, more than any NATO member-state save the United States and France. Bringing Greece into line with the NATO average would alone achieve ¾ of what the IMF is demanding through pension cuts.

Greece has long argued that its defense posture is grounded in a supposed threat from Turkey – also a big spender on things military. But surely the United States and the major western European powers can keep a cold peace between NATO allies at much lower cost.

So why don’t they? German and French arms-export interests surely explain the silence on the creditor side: Greece is one of their biggest customers.

With Greece sliding towards default and economic chaos, such silence is indefensible.

]]>http://blogs.cfr.org/geographics/2015/06/23/gunsforpensions/feed/8Greece-Troika Gap Over Primary Surpluses Has Shrunk Dramaticallyhttp://blogs.cfr.org/geographics/2015/06/05/greecetroika/
http://blogs.cfr.org/geographics/2015/06/05/greecetroika/#commentsFri, 05 Jun 2015 17:50:18 +0000http://blogs.cfr.org/geographics/?p=2536Greece has announced that it will not pay the IMF the €300 million due to the Fund on June 5. ...]]>

Greece has announced that it will not pay the IMF the €300 million due to the Fund on June 5. Instead, it will “bundle” the payments due to the Fund over the course of June into one payment of about €1.7 billion that it will make at the end of the month. This contradicts earlier pledges that it would not resort to bundling. The only country ever to have done so is Zambia, three decades ago.

While the dramatic move suggests that Athens is seriously contemplating outright default, we think such a move, at this point, borders on insanity. This is because the gap between the parties over the main issue between them, the size of the primary budget surplus (the excess of revenues over expenditures, excluding interest payments) Greece will have to achieve in the coming years is now very small relative to what it was a year ago – as shown in the figure above. In contrast, the cost of a Greek default is likely to be a complete cut-off in ECB liquidity support that will crush the Greek banking system and, also likely, force the country out of the Eurozone.

]]>http://blogs.cfr.org/geographics/2015/06/05/greecetroika/feed/0Are Fed Watchers Watching the Wrong People?http://blogs.cfr.org/geographics/2015/06/01/fedwatchers/
http://blogs.cfr.org/geographics/2015/06/01/fedwatchers/#commentsMon, 01 Jun 2015 14:17:28 +0000http://blogs.cfr.org/geographics/?p=2526One effect of the financial crisis was to change how the Fed conducts monetary policy. This could be long-lasting and...]]>

One effect of the financial crisis was to change how the Fed conducts monetary policy. This could be long-lasting and important.

Prior to the crisis, the Federal Open Market Committee (FOMC) set a target for the so-called federal funds rate, the interest rate at which depository institutions lend balances to each other overnight. The New York Fed would then conduct open market operations – buying and selling securities – in order to nudge that rate towards the target. It did this by affecting the supply of banks’ reserve balances at the Fed, which go up when they sell securities to the Fed and down when they buy them.

The Fed kept the level of reserves in the system low enough that some banks needed to borrow from others in order to meet their requirements, thereby ensuring that the fed funds rate was always an important one. The cost of borrowing through other means then tended to move up and down with the fed funds rate, thus giving the Fed effective power over the cost of short-term credit broadly.

During the crisis, the Fed’s Quantitative Easing programs – large-scale purchases of assets from the banks – drove up the volume of excess reserves, or reserves beyond those banks are required to hold, to unprecedented levels. A consequence of this is that many institutions can fulfill their reserve requirements without needing to borrow, so competition for reserves is now low and small changes in their supply no longer induce the same changes in the cost of borrowing them that they once did. This means that open market operations are no longer sufficient to drive the cost of borrowing in the fed funds market to the FOMC’s target. This can be seen clearly in the graphic above: the difference between the FOMC’s target for the fed funds rate and the actual fed funds rate increases and begins to gyrate wildly after 2007.

This is where recent legislation becomes important. Section 201 of the Financial Services Regulatory Relief Act of 2006 amended the 1913 Federal Reserve Act to give the Fed the authority to pay interest on reserves beginning October 1, 2011. The 2008 Economic Stabilization Act brought this forward to October 1, 2008. These changes gave the Fed a new tool to implement monetary policy. Paying interest on reserves helps to set a floor under short-term rates because banks that can earn interest at the Fed are unwilling to lend to others below the rate the Fed is paying. This allows the FOMC to achieve its target for the fed funds rate even with high levels of excess reserves – as can be seen in the graphic from 2009 on.

The FOMC has said that the Fed intends to rely on adjustments in the rate of interest on excess reserves to achieve its fed funds target rate as it begins to tighten monetary policy – likely later this year or early next. However, the 2006 Act gave authority for setting the rate of interest on excess reserves to the seven-member (currently five) Federal Reserve Board, and not to the twelve-member (currently ten) FOMC. This could be consequential.

The Federal Reserve Act stipulates that the interest rate on reserves should not “exceed the general level of short-term interest rates,” but does not prevent the Board from setting it well below the general level of short-term interest rates. This means that the FOMC could decide that short-term rates should rise to, say, 4 percent, while the Board, thinking this excessive, could decide only to raise the rate on reserves to, say, 3 percent. Because the quantity of excess reserves is currently so massive, it would be virtually impossible for the trading desk at the New York Fed to conduct open market operations sufficient to achieve the 4 percent target set by the FOMC. Overnight rates would therefore trade closer to the Board-determined 3 percent rate on reserves.

Section 505 of Senator Richard Shelby’s draft Financial Regulatory Improvement Act would transfer the authority to set the interest rate on reserves to the FOMC, which would restore its ability to control short-term rates generally. But unless and until such an act is passed, or the volume of excess reserves declines significantly, the Board, and not the FOMC, will control how quickly rates rise.

This is potentially important because, as the graphic shows, the average Board member is considerably more dovish than the average non-Board FOMC member. Fed watchers may therefore be overestimating the pace of rate increases because they’re focusing on the comments of the wrong committee. For now, at least, it is the Board, and not the FOMC, that wields the real power over rate increases.

As our recent CFR interactive shows, central bank currency swaps have spread like wildfire since the financial crisis. In 2006, the Fed had only two open swap lines outstanding, with Canada and Mexico, for just $2 billion and $3 billion, respectively. At its high point in 2008, the Fed had fourteen open swap lines, with as much as $583 billion drawn.

The central bank that has been most active in creating swap lines, however, is China; the People’s Bank of China (PBoC) is expected to sign a swap agreement with Chile this week, bringing the total number of outstanding swap lines to thirty-one. The extension of these swap lines is clearly part of China’s high-profile recent initiatives to internationalize the RMB.

What is most interesting about this effort so far is that whereas everyone seems interested in having a swap line with China, almost no one has thus far had any interest in using it. And when they have used it the amounts accessed have been tiny – as shown in the middle figure in our graphic above.

The only actual RMB swap use advertised by China was back in 2010, when it sent 20 billion yuan (about $3 billion) to the Hong Kong Monetary Authority to enable companies in Hong Kong to settle RMB trade with the mainland. But this is basically China trading with itself. The Korean Ministry of Finance publicized a tiny swap in 2013 in which it accessed 62 million yuan (about $10 million) to help Korean importers make payments.

The only interesting case is that of Argentina, which activated its RMB swap line last year, and has reportedly drawn $2.7 billion worth. The effect of the swaps on Argentina’s reserves is shown at the far right of the graphic.

Argentina has the right to draw on a total of $11 billion worth of RMB. Its central bank has made a point of emphasizing that, under the terms of its agreement with the PBoC, the RMB may be freely converted into dollars – which Argentina, whose reserves have plummeted from $53bn in 2011 to $31bn today, is worryingly short of.

In effect, then, what Argentina has done by activating the RMB swap line is to add “vouchers” for dollars, freeing up the actual dollars in its reserves for imminent needs, such as imports and FX market intervention, and signaling to the markets that billions more can be accessed in a pinch.

The take-away is that whereas the RMB is slowly becoming an alternative to the dollar for settling Chinese goods trade, it is still far from being a currency that anyone actually needs – except maybe as a substitute for Fed dollar swap lines, which few central banks currently have access to. If Russia’s dollar reserves continue to fall, therefore, China may be the first place it turns.

]]>http://blogs.cfr.org/geographics/2015/05/21/swaplines/feed/0Which Countries Stand to Lose Big from a Greek Default?http://blogs.cfr.org/geographics/2015/05/07/grexit/
http://blogs.cfr.org/geographics/2015/05/07/grexit/#commentsThu, 07 May 2015 15:30:00 +0000http://blogs.cfr.org/geographics/?p=2505The IMF has turned up the heat on Greece’s Eurozone neighbors, calling on them to write off “significant amounts” of...]]>

The IMF has turned up the heat on Greece’s Eurozone neighbors, calling on them to write off “significant amounts” of Greek sovereign debt. Writing off debt, however, doesn’t make the pain disappear—it transfers it to the creditors.

No doubt, Greece’s sovereign creditors, which now own 2/3 of Greece’s €324 billion debt, are in a much stronger position to bear that pain than Greece is. Nevertheless, we are talking real money here—2% of GDP for these creditors.

Germany, naturally, would bear the largest potential loss—€58 billion, or 1.9% of GDP. But as a percentage of GDP, little Slovenia has the most at risk—2.6%.

The most worrying case among the creditors, though, is heavily indebted Italy, which would bear up to €39 billion in losses, or 2.4% of GDP. Italy’s debt dynamics are ugly as is—the FT’s Wolfgang Münchau called them “unsustainable” last September, and not much has improved since then. The IMF expects only 0.5% growth in Italy this year.

As shown in the bottom figure above, Italy’s IMF-projected new net debt for this year would more than double, from €35 billion to €74 billion, on a full Greek default—its highest annual net-debt increase since 2009. With a Greek exit from the Eurozone, Italy will have the currency union’s second highest net debt to GDP ratio, at 114%—just behind Portugal’s 119%.

With the Bank of Italy buying up Italian debt under the ECB’s new quantitative easing program, the markets may decide to accept this with equanimity. Yet assuming that a Greek default is accompanied by Grexit, this can’t be taken for granted. Risk-shifting only works as long as the shiftees have the ability and willingness to bear it, and a Greek default will, around the Eurozone, undermine both.

On April 15, China’s finance ministry revealed the 57 “prospective founding members” of the new Asian Infrastructure Investment Bank, of which China is the architect. The likely founders include many U.S. allies, such as the UK, Australia, and South Korea, which the Obama Administration had lobbied not to join, seeing the AIIB as a Chinese alternative to the U.S.-architected World Bank.

The ally snub to Washington is a diplomatic failure for the Administration, although one that partially reflects the misguided refusal of the GOP-dominated Congress to ratify long-overdue IMF governance reform. This refusal made it that much easier for China to argue that new institutions to give fair voice to rising powers were both necessary and inevitable.

One major U.S. ally that has not yet made a decision as to whether to join is Japan. The Obama Administration is presumably still opposed to its participation; but whatever the merits of that position before other G7 members decided to come on board, it should be abandoned now. It is no longer in U.S. interests.

Governance of the new AIIB has not yet been determined, although China is believed to support a 75%/25% voting split between Asian and non-Asian members, with voting shares within each group allocated according to gross domestic product (GDP). China also foreswore veto power, which the U.S. has within the IMF and World Bank, in order to persuade U.S. allies to join.

With such a governance structure, China will be highly dominant within the organization – having 43% of the votes, nearly 5 times more than number 2 India (if current-dollar GDP determines voting power), as shown in the left-hand figure above. U.S. ally countries – the UK, Germany, France, and other European nations, and Australia and South Korea in the Asia-Pacific – would have only 28% of the vote.

With Japan as a member, however, close U.S. allies would have 41% of the vote – more than China’s 35%, as shown in the right-hand figure above. Therefore, even if the United States chooses to remain outside the AIIB, it should, at this point – assuming that it wishes to temper China’s dominance – be encouraging Japan to join.

The actual currency composition of China’s reserves is unknown – so no hard measurement of sales can be made. However, if we assume that the composition is approximately the same as that of other EMs – about 65% dollars, 20% euros, and 15% others – we can estimate it.

As shown in the graphic above, once we strip out currency fluctuation effects – that is, the steep recent rise in the dollar – Chinese FX reserves actually increased mildly, rather than decreased, between last June and December. Thus Bloomberg’s assertion that China had “cut its stockpile” of reserves appears erroneous. So to the extent that Bernanke’s global savings glut thesis is accurate, China continues to exert downward pressure on global interest rates.

New York Fed president Bill Dudley said that the pace of tightening would depend on “financial conditions” in the market once the Fed achieves lift-off. He pointed to the spring/summer 2013 “taper tantrum” as a reason to go slow. But he then warned of the risks of repeating the 2004 experience, when the gradual, measured, salami-slice tightening left “financial conditions . . . quite loose,” suggesting that policy should perhaps “have been tightened more aggressively.” These comments suggest that the Fed might be more aggressive this time if longer-term interest rates, like the 10-year Treasury rate, don’t rise with short rates.

The graphic above shows how the 10-year rate evolved after the 1994 and 2004 tightenings. The Fed, at least as suggested by Dudley’s comments, doesn’t seem to want to repeat either of these episodes. It wants financial conditions to tighten, but not too much.

What accounts for the different market reactions in the 1994 and 2004 episodes?

To the extent, however, that Dudley’s concerns about 2004 apply to the coming Fed tightening, we can expect the Fed to do something about it. What disturbs us is that Dudley, repeating a Fed pledge from 2011and 2014, has ruled out using the most obvious tool for affecting long rates. This is to sell longer-term Treasury securities from its balance sheet, which would put upward pressure on their yields and, almost certainly, the yield on longer-maturity private credit. The Fed holds a whopping $1.3 trillion in Treasuries with remaining maturity of 5 years or longer on its balance sheet, as the bottom figure above shows.

Dudley says the Fed will instead simply push harder on very short-term rates, through the interest rate paid on excess reserves (IOER) and the overnight reverse repurchase (ON-RRP) facility. “Macroprudential measures,” which he said should have been considered in 2004, might also be tried.

But the first, indirect, approach makes little sense if the Fed wants to affect longer rates directly. And the second is just a fancy way of saying “do something non-monetary, something we can’t specify.” Neither inspires confidence that the Fed will actually succeed in tightening financial conditions, if this is what it needs to do.

Why did the Fed, then, and Dudley personally, rule out selling assets from the balance sheet? Because they fear 1994 even more than they fear 2004. But here the Fed is once again paralyzing itself with clumsy forward guidance.

Dudley himself has acknowledged that the Fed does not know how the market will react to Fed tightening, and that it should, in fact, itself react to actual market conditions at the time. We agree. But this means that asset sales should be on the table for the eventuality that financial conditions become too loose; the Fed should not be trying to thread the needle between 1994 and 2004 using inappropriate or dubious implements.